When I wrote this recent post on the impact of austerity in the UK, I was slightly nervous about the numbers. I suggested that the 2011 and 2012 cuts in spending on goods and services alone would have reduced GDP in 2012 by between 1.25% and 2.5%, but this was a back of the envelope calculation using simple aggregates and static multipliers, and it left out the impact of important tax increases and transfer cuts. However luckily we today have a rather more systematic analysis from Dawn Holland and Jonathan Portes at NIESR. This adds in the impact of tax increases and transfer cuts, and comes to a figure of over 4% for the impact of 2011 and 2012 austerity on UK GDP in 2012.
Now at this point I should declare an interest of sorts. Holland and Portes use the Institute’s global econometric model NIGEM. I built the first version of this model. However that was so long ago, and I’m sure that the improvements subsequently made by Ray Barrell, Dawn Holland and others mean that nothing is left of my original construct.
What is especially interesting about the NIESR study is that they also do the analysis for the Eurozone economies. If we extend the calculations to 2013, Greek GDP in 2013 is over 13% lower as a result of 2011-13 austerity, Portugal’s GDP nearly 10% lower and Spain’s 6.7% lower: UK GDP is ‘only’ 5% lower. Now a cut in average incomes of 5% or more is a big deal, and it is why I keep saying that the welfare costs of these measures dwarf other considerations. But we know that this pain is not evenly spread: many people are not much affected by austerity, while others are receiving much larger cuts in their incomes.
The key point, which the NIESR study also puts numbers to, is that this pain is not in any way inevitable. It comes because austerity is being undertaken when monetary policy can do very little to counteract these effects. In more normal times, which means once the recovery is sufficiently underway such that interest rates begin to rise again, this scale of austerity will have a much smaller impact on GDP. In principle, its impact could be completely offset by monetary policy. So the argument that these large income cuts are inevitable because debt has to be brought down at some point is simply wrong.
However the NIESR study does miss one thing out of its calculations. Nowhere is there a confidence fairy that will magically persuade the private sector to spend because government debt is coming down. (As the NIESR study shows, the debt to GDP ratio actually rises because GDP falls by more than debt, but hey that’s a detail – GDP will recover one day, probably.) Now to believe in fairies you need pretty good evidence, and that is just what we do not have. A few economists think they saw some in the data, but that is not enough - nothing like enough - to justify inflicting this scale of pain on so many. (Others, of course, saw nothing (e.g. pdf).) Unfortunately too many people just wanted to believe in the confidence fairy. Normally we find those who really do believe in 'real' fairies either rather amusing or rather strange. Unfortunately some of those who believed in the confidence fairy were put in charge of running our economies.